US consumer spending sluggish, tax cuts on hold; ECB more dovish

Macro Highlights
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11/05/2017

In the United States, Q1 GDP growth disappointed, coming in at 1.9% year on year. Consumer spending eased, as we expected. Tax cuts are slow to materialise, which should hold back GDP growth in 2017. At its latest meeting, the ECB was more confident about the eurozone economy. This could pave the way for the ECB to revisit its forward guidance in the near future.

The first-quarter 2017 GDP growth figures published on Friday reflect Donald Trump's first 100 days at the White House. GDP increased by only 1.9% year on year, in line with our expectations. The key takeaway from the publication was personal consumption, which contributed only 0.2 percentage point to the annualised quarterly growth rate (+0.7%) – its worst showing since the end of 2009.

Given this low-consumption environment, the consumer confidence index is surprisingly strong, coming in at its highest level since December 2000.

Fixed investment by businesses expanded more than expected, growing 3% year on year versus an average of 0.7% in 2016. This improvement can be attributed mainly to the oil sector, where capital expenditures were up 19.3% year on year. These figures are particularly encouraging given the fact that inventories decreased in the first quarter, which means that production could be ramped up in the next few quarters.

In terms of the budget, the tax-cut proposal is currently being finalised, and the outline provided on Wednesday 26 April added little to what we already knew. The key points that were announced include a drop in the corporate tax rate from 35% to 15%, a change from an international tax system to a territorial one and a reduction and simplification in income tax rates. Congress, of course, will hash out the details. And it could very well oppose a budget proposal that is not fully balanced. Since the White House did not offer any more information on the border tax adjustment, which was supposed to offset the decline in revenues (brought on by the tax cuts), it is unclear how this tax reform plan will be funded. Steven Mnuchin, the Treasury Secretary, noted several times that tax cuts would boost economic growth, which could increase government revenues and reduce the debt/GDP ratio (which stood at 105.3% in 2016). With the US nearing the end of the economic cycle, we do not think the positive impact of the tax cuts will fully make up for the forecast decline in revenues.

The Tax Policy Center estimated the cost of Trump’s tax-cut proposal during the election campaign at USD 6.2 trillion over the next ten years. It also forecast that the tax cuts would not lead to a rise in GDP growth over that same period, since the added debt would push interest rates higher, effectively nullifying any gain.

If a serious funding proposal is not submitted to Congress, the negotiations could get difficult, since the idea of adding to the deficit is an especially touchy subject for many senators and representatives. We therefore believe it will take time to reach a deal, and this will likely limit the acceleration in GDP growth in 2017.

The European Central Bank and the Bank of Japankept their monetary policy unchanged at their respective meetings last week. While the two central banks appeared increasingly confident about the growth outlook, they both affirmed that they had no plans to make their monetary policy any less accommodative in the near future given low inflation levels.

In the eurozone, the ECB kept its deposit rate at -0.40% and its refinancing rate at 0.00%. It also confirmed its intention to continue its asset purchase programme at a pace of EUR 60 billion per month until the end of 2017 “or beyond, if necessary”. It maintained its forward guidance, reaffirming that it expected key ECB interest rates “to remain at present or lower levels for an extended period of time, and well past the horizon of our net asset purchases”. And it held to its clearly downward bias, as it reaffirmed that “if the outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, we stand ready to increase our asset purchase programme in terms of size and/or duration”.

In his introductory statement at the press conference, Mario Draghi pointed out that recent data had confirmed that the eurozone recovery was increasingly solid. The ECB therefore concluded that the remaining downside risks had further diminished. Mr Draghi reaffirmed, however, that underlying inflationary pressures were still weak and had not yet shown any convincing signs of picking up.

In Japan, the BoJ kept its interest rate on bank reserves at -0.10% and its ten-year government bond yield target at 0.00%. It also maintained its asset purchase programme target at “around” JPY 80 billion per year.

Its quarterly forecasts showed that the monetary policy committee was a bit more sanguine about the economic outlook, raising its average GDP growth projection from 1.5% to 1.6% for 2017 and from 1.1% to 1.3% for 2018. However, it lowered its inflation forecast for 2017 from 1.5% to 1.4%, leaving its estimate for 2018 unchanged at 1.7%. In other words, the BoJ still does not expect inflation to reach its target before the end of 2018.

Analysis and implications:

As we expected, the ECB and the BoJ confirmed their intention to keep their accommodative monetary policies in place despite the brighter GDP growth outlook.

We still forecast that the ECB will maintain its quantitative easing programme until the end of 2017, buying back EUR 60 billion in assets per month, as it had promised.

We also expect the ECB to scale back its assessment of the risks weighing on GDP growth at its June meeting, when it will have new forecast figures from its staff.

And we still expect that discussions on slowing the pace of its asset purchases could get under way in the second half of 2017, and that the tapering process could begin in early 2018.

We forecast that the ECB may modify its forward guidance at the end of 2017 by deleting the part about maintaining its key interest rates at present levels “for an extended period of time, and well past the horizon of our net asset purchases”. That said, we do not expect it to raise rates before ending its quantitative easing programme.

We are also maintaining our forecast that the BoJ will leave its interest rate on bank reserves at -0.10% throughout 2017 and will keep its quantitative easing programme intact in order to ensure the ten-year government bond yield remains close to 0.00%.